Iron bubble: Student loans help some, crush others

By Michael De Groote , Deseret News

Published: Sunday, Aug. 2 2015 2:50 p.m. MDT

Graduates from Skyline High pose on May 31, 2012. Graduates from high school need to make decisions about student loans. Graduates from college need to make decisions on how to pay student loans. (Scott G. Winterton, Deseret News)

The subprime mortgage bubble burst like a bomb across the country in 2007 and 2008, putting many homeowners under water and the economy into a solid recession. Now, some analysts worry that the next big debt bubble could be student loans.

Some of the signs are already here.

The Consumer Financial Protection Bureau said last April that "outstanding student loan debt has crossed the $1 trillion mark. Student loans have eclipsed credit cards as the leading source of U.S. household debt outside of mortgages. In part, this is because more students are accessing higher education. But it's also because tuition and average debt levels have increased."

Then things got worse.

At the end of September, student-loan balances had a delinquency rate higher than credit cards, a Wall Street Journal article reported. Eleven percent of student-loan balances were behind 90 days or more.

At the individual level, a student loan crisis is the result of poor choices about what loan to take out and managing the way the debt is paid. Some worry that an accumulation of individual defaults may become a broader national problem, like the subprime mortgage crisis. But the student loan "bubble" may be made of iron — large, imposing, but not going to pop anytime soon.

Mark Kantrowitz, a nationally recognized financial aid expert and publisher of Fastweb.com and FinAid.org, doesn't see imminent danger because of basic differences between what created the subprime mortgage problems and the current stresses in student loans.

Before the subprime mortgage crisis, people were flipping houses. They would buy a home, turn it around in a month and sell it for more. Many saw a 30 percent return on their brief investments.

"The value was circular," Kantrowitz says. "People were buying houses because the houses were appreciating. The appreciation was based upon the appreciation. It wasn't based upon the intrinsic value of that house found in the construction costs and the location."

With student loans, the problems are different, Kantrowitz says.

"You can't flip an education," he says. "The financial value of an education is based on the employment that it enables."

The value isn't artificially driven up and the purchased asset — the knowledge — can't be repossessed.

Kantrowitz does, however, admit that there are some "superficial similarities" to the subprime mortgage credit crisis of 2008 because loans were divvied out to homebuyers who were not likely to be able to repay. In a similar vein, federal student loans are given without looking at students' credit history because the goal is access, not profit.

The new bubble

But is there a student loan bubble?

"In order for there to be a bubble," Kantrowitz says, "there has to be a disconnect between the value of an asset and the price of an asset."

Homes were priced much higher than their real value. The prices rose because loans were so easy to get. When the ability to get those loans goes, the bubble bursts and the prices drop.

With the federal government supplying 93 percent of student loans, the ability to get those loans is not drying up.

Many of the media stories looking at student loan debt focus on students with huge amounts of debt. Yet, two-thirds of college seniors who graduated in 2011 had student loan debt, with an average of $26,600 per borrower, according to The Institute for College Access and Success. While $26,600 may seem like a lot of money, Kantrowitz doesn't think so.

"For most people, this is going to be an affordable amount of debt," he says, "It's about the same as a car payment. In fact, the vast majority of students are able to repay their student loans."

Students who graduate with six-figure debt are the exception, Kantrowitz says.

Default

"There is no rational reason for a student to default on their federal education loans," Kantrowitz says.

There are contingencies in the case of temporary financial difficulty, such as the economic hardship deferment (up to three years) and forbearances (up to five years) that temporarily suspend the repayment obligation. Kantrowitz says forbearance should only be used for the short term because interest for most loans will continue to grow.

"That just digs you into a deeper hole," he says.

The standard repayment plan is 10 years, but people can apply for extended repayment plans that go up to 30 years. This reduces the monthly payment, although it will increase the amount of interest paid. Going from a 10-year loan to a 20-year repayment plan will reduce the monthly payment by about one third while more than doubling the amount of interest paid.

Income-based repayment first became available in 2009. It was a way to make sure minimum payments were not unbearably high for people with lower incomes. Now President Barack Obama is fast-tracking a different version of the plan. It used to be that people in certain hardship circumstances could lower their payments to 15 percent of their income and would be forgiven of any outstanding balances after 25 years. Now payments can be lowered to 10 percent of income with the rest forgiven in 20 years.

Using this method is better than defaulting, because the federal government is then likely to use a 15 percent wage garnishment anyway until it gets everything.

"The government also has incredibly strong powers that force you to repay the loan," Kantrowitz says.

Jan Miller remembers when he worked for a company that serviced student loans. He was amazed when people would default on their loans without even trying the various programs available to help people with financial difficulties.

Miller, an expert on student loans and the CEO of Miller Student Loan Consulting in Salt Lake City, says people sometimes make poor initial choices when they don't know the difference between federal student loans and private student loans.

There are many programs in place to help people with federal student loans. That's not the case with private student loans.

Federal student loan borrowers can get multiple types of deferments and forbearances. Unemployment forbearance is even open for people who are employed less than 30 hours a week.

Power to take

But as forgiving as the student loan process can be (try getting forbearance, deferment or alternative payment plans from credit cards or for a mortgage), the federal government will not be denied. It can intercept income tax refunds, it can take up to 15 percent of Social Security benefit payments and the loans are rarely dischargeable in bankruptcy. People who default on a federal education loan can't enlist in the military. They can't get an FHA or VA mortgage. Renewals of professional licenses may be turned down.

What is worse, 20 percent of every collection is deducted as a collection fee before the payment is applied to principal and interest. This slows down repayment, Kantrowitz says, making, for example, a 10-year loan into a 19-year loan.

"The government is going to get its money one way or another," he says.

Defaulting on a federal education loan ruins the borrower's credit score — making it almost impossible to get a credit card, auto loan or mortgage, or to even rent, Kantrowitz says. It even may make it difficult to get a job, especially in the financial services field or in a job that requires a security clearance.

"Employers do check your credit history," Kantrowitz says.

Student loan debt, both federal and private, is not dischargeable under bankruptcy laws. There is an exception for "undue hardship," but under the strict way the words are generally interpreted for federal loans, this is so rare it is practically non-existent. Kantrowitz says in 2008 there were 72,000 federal student loan borrowers with an active bankruptcy. Only 29 received a full or partial discharge of their loans.

"You are more likely to die of cancer or in a car accident than to get your federal student loans discharged in bankruptcy," he says.

But with all the programs and protections in place on federal student loans, there is some logic in not allowing easy bankruptcy. In private student loans, these protections are not in place — something to consider when taking out a loan.

Shrinking the iron bubble

Kantrowitz also says there is a general sense that the federal government needs to do a better job underwriting student loans. He says it is possible when Congress reauthorizes the higher education act that it may look at putting better loan limits and eliminate the unlimited ability of parents of graduate students to borrow.

Obama's changes may not enable bankruptcy protection, but they are one step closer for the growing number of delinquencies.

Miller points out, however, that even default on a federal student loan is not the end. Just nine consecutive payments and the loan is not in default anymore.

"It isn't the end of the world," he says. "Those loans enabled you to go to school. They were investments in yourself. Be thankful student loans are not like other loans. You have options."